Henry Schein, Inc. (HSIC) Earnings Call Transcript & Summary

Great. Okay. So I think we are now live. Thanks so much, everyone, for joining us. We're very pleased to have with us today, Steven Paladino, Executive Vice President, Chief Financial Officer at Henry Schein; Graham Stanley as well, Vice President, Investor Relations and Strategic Financial Project Officer. My name is Matt Miksic. I cover medical devices here at Credit Suisse. We're very pleased to have Henry Schein participating in our 30th anniversary conference. So thanks so much, gentlemen, for joining us.

Very welcome, Matt.

So I thought it might be relevant to just start with a brief introduction in sort of the environment, how it has been affecting you, how you've been surviving through this past quarter. You've printed results last week, raised guidance. And maybe you could talk about, just at a high level, some of the themes that you saw in Q3 and how you managed to navigate the environment that we've all been experiencing.

Sure. Let me just note before we begin that certain comments made during this call may include information that's forward-looking. Of course, there are risks and uncertainties that affect forward-looking statements and our performance could differ from those statements. And all forward-looking statements are qualified in their entirety by the cautionary statements in our SEC filing. So with that, yes, we came off of a very successful Q3 earnings call. We feel that the markets, generally speaking, are very close to being back to pre-pandemic levels. On dental, it looks like it's pretty much there. Maybe there's a little bit more to go on medical, but both markets are cooperating well. We had a very successful quarter. We had very strong top line growth. We delivered a bottom line EPS that beat consensus by, I think it was $0.15. We raised EPS for the full year 2021. We also, given that we feel that the uncertainties in the market are significantly less than they were, we introduced preliminary 2022 EPS guidance of mid- to high single digits. So well, we feel like the markets are cooperating, we're doing well. We still are focusing on our strategies of driving growth, continuing to be more efficient. And overall, we think that we can continue to do well in these markets. Obviously, save any very unusual COVID changes that may occur. So maybe with that as an intro, I'll turn it back to Matt for questions.

Sure. Yes. So -- and maybe just if you could talk a little bit about how you thought about Q4. And you're in a little bit of a different place than some of the medical device-focused, elective-focused names that we cover. So your visibility is perhaps a little bit better. Stability in your end market's a little bit better. As you mentioned, dental is sort of appears to be back at pre-pandemic levels. But what, if anything, have you sort of factored into the sort of range or bell curve of possibilities for Q4?

Sure. We're trying to be a little bit conservative on Q4 because there were a few things that do have uncertainty. And I'll go through each one of those. The first as we described on the Q3 conference call, we're seeing in U.S. and Canada extended delays for traditional dental equipment. So we're not overly concerned about it because we think it's a timing issue. We think that the delays will push sales out of Q4 and into 2022. So again, really timing for us. But there's a little bit of uncertainty on exactly what product we'll get to be able to deliver to customers. And we recognize revenue when we deliver and install the equipment into the dentist's office. So you don't have any equipment, obviously, we can't recognize revenue on that. We'll be a little bit conservative there because while the manufacturers have given us ideas of what they think they can get to us, there's still a little bit of uncertainty there. The second thing is on COVID test kits. COVID test kits have been a high degree of volatility for us and the market. Last quarter, we did $206 million of COVID test kits. It was up from $75 million the quarter before. So big changes. But we do believe that test kits may tail off a little bit in Q4 for a number of reasons. But long term, we still think test kits will continue to be part of our sales as I think people realize there are a number of organizations and institutions that are requiring their people to either be vaccinated or tested on a weekly or every 2-week basis. So that could drive up test kits if that continues. But there's so much volatility on test kits, and we've disclosed the volume that we've achieved each quarter for the last 4 quarters, and it was as low as 75 million last quarter and as high as 270 million in Q4 of 2020. So we feel being prudent is to have a little bit of conservatism built into that. The last thing I would point out, Matt, is PPE pricing. We did note, especially in 2020, pricing really went sky high from the pricing that we were buying at and in turn would be selling that. And that pricing is now because supply chain matters are more under control. That pricing is coming back down to normalize, but there's still a little bit of pricing declines that will come forth in Q4. Those are really the items that we factored in that have a fair amount of volatility, but we still have good confidence in being able to achieve the numbers that we put out there. And again, our confidence extended to 2022 since we introduced 2022 guidance.

Right. So we'll come back to 2022 in a second, but just to maybe talk a little bit about the equipment trends. I think this is something that everyone has been asking about, you hear news about consumer manufacturers, automobile manufacturers all having issues delivering equipment and semiconductor supplies and so on. We really hadn't seen that affecting equipment or device supply in our markets. I think what you're describing is just some of the first evidence that we are starting to see something like that. What do you -- I know that you're waiting on manufacturers to deliver something for you, but what would you say is the determining factor between areas that are having more difficulty and areas that haven't yet started having trouble, say, getting their supply in there, their equipment manufacturing lines with semiconductors and the materials they need?

Yes. This is a bit of a unique situation. It's not really related completely to raw material issues, and it's concentrated just in the U.S. and Canadian market. And the reason why is there was a large equipment manufacturer in the dental space that exited the traditional equipment line a little while ago. And they didn't really give much notice to the industry that they were exiting. And that caused the other 2 suppliers who would pick up the slack, so to speak, more pressure in being able to -- they'd have to step up demand just to get back to even on the total output. So that's really complicating the situation. I think if we didn't have the first manufacturer exit, we probably wouldn't be talking about this at all. Again, it's confined to U.S. and Canada and traditional equipment, not the high-tech equipment and not outside of the U.S.

Got it. No, that's a super important point because it is something everyone's a little bit jittery about understandably. But is this -- from understanding it, it sounds like it's a bit more of a supplier disruption rather than, say, a supply chain disruption in the sense that everyone has been concerned.

Yes. The other thing that is causing a little bit of delay here is typically dental offices buy equipment, sometimes when they're moving to a new office, sometimes when they're redoing the office and there's a construction build-out. And I think people also know that construction build-outs are also delayed because of the pandemic, and that's pushing out the delivery date for us a little bit also. But again, we're not overly concerned about it. We think the demand is still very strong. Our backlog for equipment orders is up. And again, we look at it as it's really a timing difference. But we have to account for it in 2021 and 2022 guidance.

Great. So I hope you can hear me okay. I feel like my video stream here may have a little bit of a lag, but I hope that's coming across okay. But a follow-up on your testing guidance and your expectations for test kits, I think that's another area where a lot of folks who are in this market are struggling with how to guide, how to project at a plan just because the demand has been kind of up and down and now back up. Is this shifted to sort of a short term? You mentioned you're expecting that to come down. Is that sort of planning for it to come down? Or is that sort of seeing demand actually kind of fall off in the fourth quarter? How would you describe the way you think about and look at that part of your business?

Sure. So philosophically, first, I've always taken the position that the grade of the uncertainty that you have in a particular area, you just need to compensate for it by being more conservative. So we've done that, we think. Because there is also the potential that test kits could be very strong. Again, given if companies and government agencies are requiring people to either be tested or vaccinated, so it could go up. But predictability -- because predictability is difficult, we just tend to be very conservative on it. Hopefully, we'll be a tad conservative, and we'll have a little bit of upside, but too early for that. We did see a little bit of in the beginning of Q4 when we were on our Q3 conference call, we did see a bit of slower sales in that first -- beginning part of Q4, but not dramatic at this point.

Right. Well, that's understandable, I guess, given what we saw in August and September. So one last comment just on -- I'd love to get to '22 and to obviously Henry Schein One Distribution. But on mix, you mentioned some comments on the third quarter call about the impact of some of the rising volume business lines mix and margins because can you describe that and what you're expecting for Q4 and how that sort of either stabilizes or shakes out do you expect in '22?

Sure. So when we look at mix within our distribution businesses, we haven't given specifics, but we have said that the Medical business does have a little bit lower gross and operating margins than the Dental business. And with Medical growing much faster than Dental this past quarter, that was part of the mix issue. Within the mix, there's also test kits because test kits and PPE, they're decent margin, but they're closer to the overall Medical margin than the corporate average. And that mix shift is also a little bit of a headwind for us. But we do feel that longer term, that we have opportunity to expand margins. We haven't given specific guidance on the amount of annual expansion that we expect to do. But we do think that longer term, we can expand operating margins. We look to do it through 3 or 4 different initiatives. One is growing our higher-margin businesses faster than the core distribution business. So namely, dental specialties and technology and value services. Two, we think some of the initiatives that we have like One Distribution and other restructuring opportunities, provide us the ability to take cost out of the system. And three, we feel that we can continue to, with additional volume, leverage expenses to drive up the margin. So there's still opportunity. We haven't said, Matt, how much of the margin expansion we're expecting in 2022. But maybe on the Q4 conference call, we'll give a little bit more detail on 2022 guidance.

Fair enough. So then maybe turning to '22. It's difficult, I think, for everyone to sort of plan through Q4, much less into '22. Some of the things, I think, that other companies find a little daunting is staffing issues, input costs, labor costs, and then, of course, the odd chance of another surge or wave that goes through one geography or another. Just trying to understand how you look at sort of the bell curve of possibilities and positioned yourself with your initial mid- to high single-digit EPS growth for next year. What goes into that? And how does that develop, I guess, as you get through Q4 and into Q1, and you have a little more visibility?

Sure. Well, first, one of the key reasons why we introduced 2022 guidance was really to show that we feel like the markets are back to where they should be for the most part. And we do have confidence in our ability to achieve earnings. Because, quite frankly, it would have been easy just to say on the third quarter conference call, we'll talk about 2022 on the fourth quarter conference call. We wanted to show the confidence. We do have a budget for 2022, which is almost complete that we can look to. That's a bottoms-up budget that allows us to have that confidence. Remember, some of the things I just talked about for 2021 like the equipment, which is a headwind for 2021 is a tailwind for 2022. And we're continuing to try to be conservative on test kits, PPE pricing and things like that because of the uncertainty there. But overall, we feel like we do have confidence in being able to achieve those -- the guidance, and that's why we introduced it.

Fair enough. Well, and that's, of course, growth off of your guide for '21. And so if you've taken a relatively balanced or careful view of Q4 and a careful initial view of '22, then I think folks can do the math on what all that can mean as we get further to the end of the year and into Q1. Maybe we could shift to Henry Schein One, since that's obviously a big strategic initiative for the company. Maybe if you could just talk about -- I assume most importantly, what it means for the customer. To what degree this is answering a call of the customer in sort of consolidating the sort of digital sort of front end to the market?

Sure. So first, our Henry Schein One represents the largest component of our technology and value-added services segment, probably represents about 70% of that segment. But we also have a number of financial services in there as well as recently acquired eAssist that does outsourced dental billings for clients. So really Henry Schein One is, I would say, a unique situation where we're really the only one in the dental space that has software as well as services and really the whole gamut of software and services. Most people in the market either have software on the one hand or some services on the other hand and also don't have much market penetration. We have 40% plus of the U.S. and Canadian dental market using one of our software solutions. So really, we see the growth. Of course, we want the 40% to creep up, but we see greater opportunity for growth in services where we can get existing customers to use more services. So services include everything from basic services like eClaims processing and credit card processing, to more services that help with patient demand generation, help with backup storage, off-site storage, web hosting the dental practices' website and a number of other services. These areas, especially the patient demand generation, are really very interesting and high demand systems. And so we think that there's a big opportunity. And the other big opportunity is there is yet to be a migration in our space from a server-based software solution to a cloud-based solution. It's inevitable that it will occur. It's occurred in most other technology areas already. Dentistry tends to be a little bit slower adopter of technology in some cases. But we have a cloud-based system as well as a server-based system. And there are a number of companies that don't have a cloud-based system. So we see that that's an opportunity for us to migrate customers over to the single platform. It's called Dentrix Ascend. And we're excited about that because we think we can lead that migration.

Okay. So when I hear you describe this and heard you kind of go through it and Stanley go through it on the conference calls, it's almost like you're -- as you described, there's folks with a digital strategy and there's folks with a sort of feet-on-the-street service strategy. You're kind of combining these 2 things almost -- with these sort of acquisition, it would feel like there's a cross-selling opportunity or something like that. And I'd love to understand, especially given some of the changes in sort of the digital strategy, particularly around customer acquisition, lead generation that has sort of popped up in the last several months. Which one of those levers do you think is going to be the focus in the next 6, 12, 18 months for -- as you assist practices and helping to drive new customers and market to customers, is this a balance? Is there a little bit of a shift back to traditional? And how do you think about that given what's transpiring?

Yes. So we look at ourselves as more than just an efficient distributor of product from point A to point B. Of course, we do that. We think we do it as well or better than anyone in the space. Now service levels are generally very high, high fill rate of over 99%, not today because of some manufacturers, but generally speaking. And also, generally, you place the order today, and you're receiving it in the ordinary course tomorrow. But we've also realized that customers need and want more than just that good supply chain management. And that's really where the technology and value-added services come in. Some of our competitors don't have a technology platform. The ones that do, the platform is much small and doesn't have all the capabilities that ours has. So we see really the opportunity to go to market with really a full integrated suite of software and software solutions that really, I think, will be difficult for anyone to match because no one has all of the products and services that we have to be able to pull it together. And we did a recent survey with customers. And what came up very high on the survey was rather than them going out and buying a best-in-class in each particular product area, they said, that's interesting, but what's more interesting is an integrated suite of services. They don't want to have to worry about how this service talks to the practice management software or vice versa. They want it really all integrated. So we see that playing into our strength as a competitive advantage versus some other people.

Got it. So maybe if we can talk a little bit about -- we're talking about what it means at the front end and how it fits with the environment and what customers are asking for. What does it mean for your organization kind of in the back end in terms of rationalizing facilities or sharing services or driving leverage internally?

So it's a little bit different from the Henry Schein One. Henry Schein brings all of the value -- not all of it, but a lot of the value-add and technology value-add. But as far as the basic distribution business, there's still opportunities for us to take cost out of the system. We think that there's opportunity with this One Distribution concept that we talked about on the Q3 conference call. And just as an example, if you look at our U.S. Dental and U.S. Medical business, what we call the back office, namely purchasing, warehousing and distribution, is all really a shared service for U.S. Dental and Medical. So that's really been done a while ago. But One Distribution is focusing on other areas, more on the front end, more on the sales, marketing, customer contracting, customer service, things like that area, where we really are independent within Dental and Medical. And we really want to have more shared services and could gain some better service to customers, so to improve customer satisfaction, but also to take cost out of the system. So that's something that we feel like there's a nice opportunity for us, and that's why we're talking about One Distribution more recently.

Got it. Okay. So One Distribution more of a middle-office, front-office service line sort of opportunity, it sounds like. So where are the challenges in that? You're rolling it out at a sort of staged fashion, which makes sense. What are the -- what things do you worry about, hoops and hurdles or rough spots or things that you need to sort of iron out in the early stages of rollout to make sure this thing delivers what you're looking for.

Well, it's not going to be a big bang. We're going to look at a particular shared service or area and focus on one at a time. So that limits the risk significantly. But we also have done this before when we do acquisition, integrations and things like this. So I would say it's a core competency. It's something that we have a strengthening, and we'll be able to do that. We just took the U.S. Dental or -- North American Dental and Medical businesses under common leadership. That was part of the announcement that Stanley walked through on the conference call. And we think that will help accelerate this migration to One Distribution. Because it's always a little bit more cumbersome when it's not under the same leadership to get things done. So now with U.S. and Canadian Dental and Medical all under a person named Brad Connett, who is a 20-year plus veteran of Henry Schein, who's been running our Medical business for quite some time, we see that as helping to accelerate this One Distribution concept.

Okay. And so metrics back to investors, what are going to be some of the things that investors will see you'll be able to talk about as you roll this out in terms of benefits and sort of indications of success?

Sure. So right now, it's a little premature. We haven't given some metrics there. But overall, we obviously feel like this will be a key factor in driving operating margin expansion. We still believe that long term, the company can get continued margin expansion as this has been one of the initiatives. So again as we develop more detailed plans, we'll probably share more information with the investors in the not-too-distant future.

Okay. As far as sort of -- to the extent it's -- to some degree, a restructuring plan, you haven't put a target on it yet. Should we expect that next year? Should we expect it the year after, after you get through the U.K.? Or when will you start being able to talk a little more specifically about the benefit to margins?

Yes. I think it will be sometime during 2022, but it's still a little early on. We have internal goals and objectives and plans, but they're still being shaped right now.

Okay. And so maybe sort of zooming out a little bit, you've talked about, as I mentioned upfront, Dental being back, Medical kind of almost being back. I mean what's been the variability of businesses on the Medical side? And sort of which businesses within Dental still have some room to sort of regain some momentum here?

Sure. Well, on Medical first, I would say that during the height of the pandemic, a number of procedures that were elective, surgical procedures and the like, were delayed. And they're still not fully back, those elective procedures. We sell not only to physician offices, but to surgery centers. And we think there's more opportunity for that to continue to get back to more normalized levels. But it's pretty close already right now. And with the expanded use of PPE and COVID test kits, the market is coming back -- will be back at a higher level than pre-pandemic because of those things. Dental is, I would say, U.S. and Canada pretty much back to pre-pandemic. It's only spotty in some geographic locations where it's not quite fully back. And I would point to maybe New Zealand and the U.K. in our businesses that are not quite back to pre-pandemic levels, but they're pretty close, and we do see it as something that will get back relatively quickly. But again, the bulk of our markets are back to "normal". And that's a good reason why we continue to be optimistic about '21 and '22.

Sounds good. And just on that point of recovery, I think I may have mentioned staffing as one of the things that folks are obviously worried about. Can you talk about the extent to which staffing in the offices that you serve, even in Dental, are -- what do you expect that to look like into Q4 and into Q1, to the extent you can predict anything on that front?

And you're talking about our own internal staffing. Is that right?

No. I'm talking about like your...

Our customers?

In other words, driving as a slight headwind to utilization depending on the market that you're in or the type of office or the type of care that's being provided.

Yes. I would say that's a little bit of an issue for some of our customers, making sure that they're fully staffed. We do have a small business within Henry Schein that helps with staffing of professionals there. I don't think it's a significant issue for our customers, but there are parts of the country where it's taking longer to bring in quality people. But it's not a big issue for us that we see at this time.

Sure. Vacations kind of normal, all those things kind of a little steadier in your end markets, it sounds like?

That's right. That's right.

All right. So maybe finally here in the last several minutes that we have, if you could talk a little bit about your sort of posture for sort of use of cash and posture for additional strategic investments.

Sure. Well, first, I'll note, and I think people noticed that we have a really strong balance sheet. We're under one turn of debt to EBITDA. I think it's closer to 0.6 turns on Q3. Some people argue, well, your balance sheet is too strong, why don't you lever it up a bit? And of all the criticisms I get, that's the one I don't really mind having a strong balance sheet.

I hear you're getting a lot of positive advice and suggestions on that front, what to do with that capacity.

Yes. And our goal really is to continue doing strategic acquisitions, continue with our stock buyback. And those will be the capital allocations, the bulk of the capital allocation, besides, of course, working capital and capital expenditures, but the bigger uses will be on those 2 items, acquisitions and stock buybacks. We still think that there's plenty of acquisition opportunities for us. Nothing really too large because they just don't exist that many of them in our space. But if you do half a dozen to a dozen of them a year, they add up at the end of the year, and they also are nice platforms for future growth. And on stock buyback, of course, we feel like our stock is still undervalued, and it remains a good investment opportunity for us to buy back our stock going forward. So we'll continue to do that. I think those are the main areas for capital allocation.

Okay. And then within strategic investments, anything -- I know you get this question often I'm sure, but any places in the array of products or services that you provide, where you feel like we're either going to have to build something, I guess, in terms of software or we're going to have to acquire something in terms of a product or a team that specializes in a slot and that sort of array of software and services that you provide. Anything that you'd highlight that you'd like to be in that you're not in?

Well, I would say it's more expanding geographically some of the things that we're in. As I said, Henry Schein One is a U.S.-centric. The bulk of the revenues and business is in the U.S., although we have an outside the U.S. business, but it's small now, so we'd like to continue to do bolt-on acquisitions, both to expand geographically as well as if there's additional services that can help us integrate into the services that we have. So the focus will be on technology and value-added service acquisitions as well as in the specialty arena that we still see opportunity for growth there. And then we always use acquisitions either as in existing markets as tuck-ins or when we enter into a new geographic location, we almost never do it without a platform acquisition since there are a plenty of those. So those are the key areas to focus on for acquisition activity.

Okay. So you mentioned a little bit earlier that you feel like Dental is sometimes being late in adoption of technology or latest iterations of technology. You mentioned, I think you were talking about the cloud. Advanced surgical technology, advanced robotics and things like that, AI has sort of become quite a wave across the rest of medical devices and medical technology. Where do you stand on those types of investments and rolling those into your offering?

We have the broadest offering of anyone. So we have all the product categories. We have all the key areas, but take something as simple as a digital X-ray. So if you look at the medical side, the digitizing of medical X-rays has occurred, I don't know, several years ago. It's -- I think it's hard in this country to go to a hospital or a radiography center and have a film X-ray. It's pretty much all converted, whereas on the Dental side, it's probably 60%, 70% of the market. So there's still a nice opportunity to get the rest of the market digitized on X-ray. And it has a lot of benefits for the dentists. It's faster procedure time. You get that image literally instantaneous versus developing with film, less chemicals, lower radiation for the patient and the list goes on and on. So it will happen. It's just, for whatever reason, it's taking a little bit longer in that dentistry. And again, that's something that we've seen in other areas, too. But it's not that far behind. It's just a little bit behind. Similarly, with -- in dentistry, there's this CAD/CAM technology, which allows to take a digital impression of the tooth and ultimately to mill a crown share side for 1 day dentistry rather than 2 days. So that's also good for the patient and the dentist. That is low adoption today. But over time, we think it will get closer to standard of care.

Okay. So room for penetration and sort of the technology conversion opportunities that you have. It doesn't sound like you need to be sort of on the bleeding edge at the moment and sort of pushing new trends with that kind of opportunity.

Yes. And being on the bleeding edge in our space is not the best thing because it does take time for adoption. So we like where we are right now.

Sure. And now it's expensive to be on the bleeding edge. All right. Well, with that, we're just about at time. If there's anything else that you'd like to share in the last minute or so that we have that we haven't covered, I'd be glad to turn it back over to you.

Yes. I don't think there's anything that we -- I think we covered the main areas that we're getting a lot of questions on from other investors. So I don't have anything additional. But thanks, Matt, for hosting this, and we very much appreciate it.

You bet. Look forward to working with you. Thanks so much.

Okay. Thank you.

Take care.